While an increasing number of consumers are aware of their credit scores, a good deal of confusion still exists about what does — and doesn’t — impact your score. For example, there is a popular myth that carrying a balance from month to month will somehow help your credit.
This is not true, however. While you do need to occasionally use your card to build up payment history — you can’t have a payment history if you don’t, you know, make payments — which is an important part of your credit score, you don’t need to carry that balance beyond your due date to reap the benefits.
And, more importantly, you shouldn’t carry a balance beyond your due date because that’s when interest fees will start to come into play. Interest fees compound daily, which can get expensive even if you have a card with a relatively low APR.
However, there are other reasons to avoid carrying a balance or, worse, maxing out your credit cards beyond the inevitable interest fees. The most important of which is the potential impact on your credit score.
The Direct Impact is to Your Utilization Rate
Each month, usually around the time your statement period ends, your credit card issuer reports your card balance to the credit bureaus to be updated on your credit reports. This balance is used by credit scoring agencies and lenders to determine your utilization rate or ratio, which is the ratio of how much debt you have to your total available credit.
For example, if you have a balance of $500 and a total credit limit of $2,000, then your utilization rate is 25%. A high utilization rate is seen as risky by models and creditors because it means you may be struggling to pay off your debts.
So much so, in fact, that your utilization rate — both overall across all cards as well as per individual card — is worth up to 30% of your FICO credit score. As a result, having one or more credit cards with an extremely high utilization rate, such as cards that are maxed-out or near their maximum limit, can cause your credit score to drop by dozens of points.
On the bright side, that damage isn’t permanent. Paying down your balances to reduce your utilization rates can help your score rebound in a month or two when the new, lower balances are reported to the credit bureaus. However, there could be more lasting repercussions.
Watch Out for Secondary Consequences
One of the most common consequences of maxing out a credit card is that the issuer may see the high utilization rate as a sign of financial trouble — which means you suddenly seem like a high-risk investment. Some issuers may respond by reducing your credit limit to the current balance on your card (or lower) to avoid the potential of your debt level rising, which can cause your utilization rate to increase even more.
In extreme cases, issuers may decide to cut their losses and cancel your card entirely, leaving you with a limited window to pay off your balance. Issuers can close your account at any time, and they’re under no obligation to provide notice if they choose to close your account.
Additionally, maxed out credit cards can negatively contribute to your debt-to-income ratio, which is an evaluation of the total amount you owe on your debts each month versus your monthly income. A high debt-to-income ratio is a red flag for lenders and credit card issuers, one that can cause you to be denied for new credit if creditors don’t believe you can repay your debts.
Dealing with Maxed-Out Credit Cards
The most obvious solution to maxed out credit cards is also the most basic tenant of responsible credit card use: Only charge what you can afford to repay that month and pay your bill in full. If you need to make purchases that will put your balance close to your limit, consider making multiple payments during the month to avoid having a high balance reported to the bureaus.
Another way to avoid maxing out any specific card is to spread out your purchases when possible. A low to moderate amount of debt spread out across multiple cards will tend to be better for your credit score than the same amount of debt on a single card.
Alternatively, credit card consolidation with a personal installment loan can shift debt from a maxed out credit card to a loan, thus reducing your credit utilization rate. Even better, if you can get a loan with a low APR, you could save on interest fees, as well. Keep in mind that consolidation may not help with your debt-to-income ratio, however, and that opening a new account may have its own credit repercussions.